Risk of escalation of trade frictions temporarily eased—Comments on the results of China-US trade talks at G20

2018/12/03

The leaders of China and the
United States met in Buenos Aires on December 1. Wang Yi, China’s state
councilor and foreign minister, said that the Chinese and US leaders reached
consensus to stop imposing new tariffs. Wang Shouwen, China’s vice commerce
minister and deputy international trade representative, gave more details about
the consensus reached by China and the US on trade at the G20: 1) the US’s
tariffs on US$200bn worth of Chinese products will remain at 10% after January
1, 2019; 2) both parties decided not to impose new tariffs on other products;
and 3) for the 25% tariffs currently in place, China and the US will step up
negotiations in the direction of cancelling them.

The White House said in a
statement that: 1) President Trump has agreed to leave the tariffs on US$200bn
worth of Chinese products at the 10% rate on January 1, 2019, and not raise them
to 25% at this time. 2) China will agree to purchase a not yet agreed upon, but
very substantial, amount of agricultural, energy, industrial, and other products
from the US to reduce the trade imbalance between the two countries, and has
agreed to start purchasing agricultural products from US farmers immediately. 3)
President Trump and President Xi have agreed to immediately begin negotiations
on structural changes with respect to forced technology transfer, intellectual
property protection, non-tariff barriers, cyber intrusions and cyber theft,
services and agriculture. Both parties agree that they will endeavor to have
this transaction completed within the next 90 days. If the parties are unable to
reach an agreement at the end of this period of time, the 10% tariffs will be
raised to 25%.

The risk of a sharp decline in
China’s exports to the US in early 2019 is eased. If the US raises its tariffs
on US$200bn of Chinese goods from 10% to 25% as originally planned, the impact
on China’s exports to the US would be similar to those from the already imposed
25% tariffs on US$50bn of goods and 10% tariffs on US$200bn of goods. US imports
of Chinese goods on the US$50bn tariff list already declined 17.1% YoY in
September, while imports of goods on the US$200bn tariff list still increased
20.7% YoY in the month. If the tariffs on the US$200bn of goods are left at 10%
or even cancelled, the risk of a sharp slowdown in China’s exports to the US
should be eased.

The risk is reduced or delayed
for industries that may be significantly impacted by US tariffs on US$200bn of
Chinese goods, such as furniture, electronics and machinery. Having classified
US imports from China according to China’s industrial classification, we found
that the tariffs on US$50bn of goods only cover a few industries such as general
equipment, special equipment, transportation equipment, while the tariffs on
US$200bn of goods cover more and broader industries. If the tariffs on US$200bn
of goods are raised to 25%, we estimate more than half of China’s manufacturing
industries would see the average tariff rate on their exports to the US rise by
more than 10ppt. Taking into account the US’s share in China’s exports and the
export dependence of China’s industries, we found that the furniture,
electronics and machinery industries are more affected by the tariffs on
US$200bn of goods. If the tariffs are not further raised, the potential impact
on these industries will be significantly reduced or delayed.

China may resume imports of
soybeans, crude oil and other goods from the US. China has basically stopped
importing soybeans, crude oil, sorghum and other goods from the US in the past
few months (even crude oil is not on the tariff lists). As the northern
hemisphere enters winter, the US becomes the main harvest region for soybeans in
the world. The CICC commodity team estimates that if China does not import US
soybeans and reduces feed protein content, her annual soybean shortage would be
about 4.6mn tonnes. Since China imported 32mn tonnes of soybeans from the US in
2017, if China resumes soybean imports from the US, the domestic soybean supply
and demand relationship would be reversed. An increase in China’s imports of
agricultural and energy products from the US will likely put downward pressure
on domestic inflation and reduce China’s imports from other
regions.

The consensus reached gives the
two countries 90 days for trade negotiations, but there is still uncertainty in
the negotiations. While the easing of trade frictions is likely to boost
domestic market sentiment in the short term, the evolution of trade frictions
still depends on the results of future negotiations. In addition to proposing
that China purchases more US goods, the US also demands “structural changes with
respect to forced technology transfer, intellectual property protection,
non-tariff barriers, cyber intrusions and cyber theft, services and
agriculture”. In an optimistic scenario, trade frictions can be further resolved
after the 90-day negotiation period. However, the possibility of frictions
escalating again cannot be ruled out.

Domestic economic policies
still face challenges. External demand dragged China’s GDP growth in 1–3Q18 down
by 0.7ppt, while domestic demand contributed 7.4ppt to the growth. Looking
ahead, global economic growth may decelerate. Even if trade frictions do not
escalate, external demand may still weaken. In terms of domestic demand, real
estate may become a drag on economic growth next year. The CICC real estate team
expects property sales in GFA terms and real estate development investment in
2019 to shrink 10% and 5%. Although China will likely increase its fiscal
spending and infrastructure investment, the support from fiscal policy may not
be able to offset the impact of weaker real estate and external demand if more
tax cuts are implemented at the same time. In addition, monetary policy needs to
strike a balance between stabilizing domestic demand and stabilizing exchange
rate. Real estate policy also needs to strike a balance between stabilizing
property prices and stabilizing economic growth.